II Stance of Monetary Policy for the second half of 2000-01
I Mid-Term Review of Macro-economic and Monetary Developments in 2000-01
III. Financial Sector Reforms and Monetary Policy Measures.
30. On April 1, 2000, the Reserve Bank had announced a number of measures to enhance liquidity and reduce the cost of funds to banks. These measures included a reduction in the Bank Rate, CRR and the Repo rate by 1 percentage point each. On April 27, 2000, the annual monetary and credit policy statement expressed RBI's intention "to continue the current stance of monetary policy and ensure that all legitimate requirements of bank credit are met while guarding against any emergence of inflationary pressures due to excess demand. Towards this objective, the Reserve Bank will continue its policy of active management of liquidity through OMO, including two-way sale/purchase of treasury bills, and reduction in cash reserve ratio as and when required". On July 21, 2000, however, RBI increased the Bank Rate by 1 percentage point and CRR by 0.5 percentage point. Short-term repo rates were also substantially raised in several stages, soon after the introduction of Liquidity Adjustment Facility (LAF) on June 5, 2000 (these rates have recently been reduced). The change in course within four months of the April 1 reductions in Bank Rate/CRR has elicited a fair amount of comment and debate among experts, market participants and bankers.
31. It is useful to recall that, while confirming the intention to continue the then prevailing stance of monetary policy, the April policy statement had also cautioned that, "it cannot be over-emphasised that the above outlook can change dramatically within a relatively short period of time in the event of unanticipated domestic or international events. Several unfavourable events that affected the outlook for the economy during the years 1997 through 1999 point to the need to respond quickly and to change course, if and when required". Further, it was stated that, "the Reserve Bank will continue to monitor domestic monetary and external developments, and tighten monetary policy through the use of instruments at its disposal, when necessary and unavoidable". Moreover, banks and financial institutions were specifically urged to, "make adequate allowances for unforeseen contingencies in their business operational plans, and take into account the implications of changes in the monetary and external environment on their operations". Thus, the possibility of "a change in course" and "tightening of monetary policy" in the event of a change in the domestic or international situation was specifically recognised in the April policy statement. And as it happened, such a change of course did indeed become necessary a few months later.
32. It may also be mentioned that, in the conduct of monetary policy, a change of course in response to the emerging situation is often unavoidable. This has also been the experience of most central banks in developing economies as well as industrialised countries with well developed financial systems. For instance, the US Federal Reserve reduced interest rates in successive steps from September to November 1998 from 5.5 per cent to 4.75 per cent, but, revised the stance in June 1999 and hiked the rate in successive steps to 6.5 per cent beyond the level at which easing commenced. Similarly, the European Central Bank, which strongly opposed the easing stance till March 1999, actually reduced the interest rate by 50 basis points in April 1999, but subsequently changed course when new information became available and hiked the rates in November 1999. The Bank of England which eased the rates in June 1999, reversed its stance and hiked the rates in September 1999.
33. As financial systems become more open and more deregulated, it becomes difficult to anticipate or accurately predict the market behaviour. Financial market conditions, and market actions, in turn can have important impact on macro-economic outcomes in terms of investment, growth, inflation or external stability. For example, when markets were highly controlled, bank interest rates were fixed by the Reserve Bank, and credit allocation was centralised, it was possible for monetary policy prescriptions to remain fixed for a long period. As we move towards a more efficient, more competitive and a more vibrant financial system, it is necessary to accept the fact that monetary instruments will be used more flexibly. It is also essential for market participants to take greater recourse to appropriate asset-liability and risk management techniques in order to take account of the unanticipated changes in monetary conditions and the interest rate outlook.
34. Apart from the impact of sharp increase in the international prices of crude oil, the domestic inflationary outlook is somewhat uncertain. As on September 23, 2000, the point-to-point inflation in "manufactured products" which account for a weight of 63.75 per cent was 2.91 per cent and in "primary articles" accounting for a weight of 22.03 per cent was 1.25 per cent. In fact, the prices of foodgrains declined by 5.44 per cent. On the supply side, stocks of foodgrains at the end August 2000 were at a comfortable level of 40.8 million tonnes. The low rate of inflation in "primary articles" and "manufactured products" combined with comfortable stocks of foodgrains are sources of comfort in the management of the overall inflationary environment. The M3 growth as on September 22, 2000 was 13.6 per cent which was also in line with the projected growth of 15.0 per cent envisaged in the April policy statement and thus, as of now, no undue pressure from the demand side is anticipated. However, as mentioned earlier, the external outlook principally in respect of crude oil prices, remains highly uncertain and is a cause of concern.
35. Taking the above factors as well as Government's borrowing requirements into account, as per present indications, liquidity conditions are likely to remain adequate during the rest of the year. The banking system is not expected to face any difficulty in meeting fully the demand for commercial credit from industrial and other sectors. The Reserve Bank also stands ready to provide appropriate liquidity through its LAF as necessary in order to manage the overall liquidity situation in the economy.
36. During the rest of the current year, the interest rate outlook would crucially depend on external market conditions, domestic developments in respect of the overall rate of inflation, demand for credit from the commercial sector and Government's borrowing requirements. To the extent possible, It will continue to be the endeavour of the RBI to maintain a stable interest rate environment. However, as mentioned in the April policy statement, it will be prudent for banks and financial institutions to make sufficient allowance for unforeseen contingencies, including possible changes in monetary measures, in their business operational plans though, as of now, Reserve Bank's policy will continue to be to maintain stable monetary conditions.
37. In the last four months, the LAF introduced since June 5, 2000 has been effectively used to influence short-term interest rates by modulating day-to-day liquidity conditions and to contain volatility in foreign exchange market. For a few weeks, the repo rates were increased sharply and remained high. In the more recent period, they have been brought down to a more reasonable level. The LAF would continue to be operated in a flexible manner, both in terms of the applicable rates and tenors, in keeping with the developments in financial markets. It may, however, be mentioned that the full effectiveness of the LAF is at present constrained by the automatic additional liquidity available through refinance and liquidity support facilities to banks and primary dealers.
Click here to read AnnexureI for :
Summary of Guidelines for Issue of
Commercial Paper (CP)
Click here to read AnnexureII for:
Summary of Guidelines on Categorisation
& Valuation of Banks'Investments
Click here to read AnnexureIII for:
Guidelines on Bank Financing of Equities and Investments in Shares